CRIEFF Discussion Paper Number 0025

How Well Does the Market Allocate Entrepreneurs?

Baochun Peng

Abstract
This paper offers a synthesis of two Schumpeterian views: that growth is driven by innovation, and that the level of financial market development affects the growth process. We adopt an endogenous growth model where growth is driven by R&D activities of entrepreneurs. Entrepreneurs must borrow to fund R&D, but heterogeneity and unobservability of entrepreneurial ability creates credit restriction. The extent of financial market development is defined as the number of high ability agents in the financial market. Having a more developed financial market facilitates the allocatin of resources to the innovation sector, at the same time reduces the number of entrepreneurs available to the innovation sector. We characterize equilibrium in the financial market, and find that market allocation of entrepreneurs only coincides with the growth maximising allocation when all value created by innovation are divided by entrepreneurs, otherwise the market allocation is typically not growth maximising, and low grow trap may exist.

JEL Classifications
G20, M13, O16, O31

Keywords
Growth, Entrepreneurship, Financial market

Baochun Peng
University of St Andrews

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